Demographics can explain two-thirds of everything, University of Toronto professor David K. Foot famously quipped. And according to Charles Goodhart, professor at the London School of Economics and senior economic consultant to Morgan Stanley, demographics explain the vast majority of three major trends that have shaped the socioeconomic and political environments across advanced economies over the past few decades. Those three would be declining real interest rates, shrinking real wages, and increasing inequality.
Goodhart & Co.’s contentions aren’t necessarily novel, with versions of these conclusions having been articulated by Toby Nangle, head of multi-asset management at Columbia Threadneedle Investments, and given a U.S. focus by Matt Busigin and Guillermo Roditi Dominguez, portfolio managers at New River Investments.
But Goodhart's work is a particularly thorough and forceful manifesto.
The conditions that fostered these three intertwined major developments are nearly obsolete, writes the former member of the Bank of England's Monetary Policy Committee and other analysts from Morgan Stanley, and this has profound implications for the framework of the global economy in the decades to come.
Goodhart argues that since roughly 1970, the world has been in a demographic sweet spot characterized by a falling dependency ratio, or in plainer terms, a high share of working age people relative to the total population.
At the same time, globalization provided multinational companies the ability to tap into this new pool of labor. This positive supply shock was a negative for established workers, forcing down the price of labor as capital flowed to these areas.
"Naturally, and quite properly, the West supplied much of the management; the East supplied the labor," wrote Goodhart.
Outsourcing labor to less costly locales kept wages at home from rising too fast. This, in turn, entailed that inflationary pressures were benign, as best depicted by the concept of the Great Moderation, or the idea that central bankers were better able to stabilize the business cycle.
As companies were encouraged to boost capacity with workers rather than capital equipment, this put downward pressure on the cost of the latter.
"Access to a new reserve army of cheap global labor through globalization has encouraged companies to invest in this workforce rather than in capital at home. A garment company, for example, could choose to build a highly automated, capital- intensive factory in the U.S. or build a low-tech, high-labor factory in the Far East," said Toby Nangle, who published a column on the connection between labor power and interest rates in May. "For years, companies have been choosing the latter option, which reduces the requirement for capital in the West, thereby reducing the price of that capital."